India: From low inflation to low rates; the RBI is set to pivot
After a year of low underlying inflation, there is both scope and a need for policy recalibration
- Consensus forecasts reflect upside in food inflation risks and delayed monetary policy easing.
- With high-frequency data pointing to lower food prices, low core inflation and rising downside risks to growth, we see policy inflection around the corner.
- Nomura’s house view is of faster and deeper policy rate cuts in this cycle, relative to consensus.
The view from the street on India’s inflation and monetary policy are aligned to the Reserve Bank of India (RBI)’s hawkish guidance of upside food inflation risks and a delayed and shallow policy easing cycle. Consensus expects 50 basis points of cuts in total in this cycle, starting in December or later. Our house view differs from the consensus.
Our assessment is that underlying inflation is already aligned closer to the RBI’s 4% target, and as food prices ease, inflation is likely to undershoot RBI forecasts. We expect the RBI to cut its policy rate by a cumulative 100 basis points to 5.50% by mid-2025.
High-frequency price indicators in the month of September already point to food prices easing, and the combination of good monsoons, a cobweb cycle for pulses, and the government’s proactive supply side management suggest that concerns over higher food inflation are unwarranted. Underlying inflation for food ex-vegetables remains underwhelming. Overall, we forecast average food price inflation of around 4.5% until March 2025, a significant reduction from the 8.3% so far this year.
There is also evidence of broad-based disinflation in that nearly 68% of the consumer price index (CPI) basket has an inflation rate of 4% or less, the highest since early 2020. Core inflation remains benign. Adverse base effects should push year-on-year core inflation higher from the low-3s towards 4% by Q2 2025, but underlying momentum is likely to remain below 4%, due to low input costs, moderating wage growth and soft demand. The downtrend in inflation expectations and moderating wage growth mean second-round effects are unlikely, in our view. We expect the RBI to trim its FY25 headline inflation forecast of 4.5%, and we see inflation averaging 4% in FY26.
Additionally, high-frequency data also point to a softening of growth momentum. Part of this is due to transitory factors, but there are also some persistent elements. We expect GDP growth to moderate from 8.2% y-o-y in FY24 to 6.7% in FY25 (RBI: 7.2%), with rising downside risks in FY26.
Financial stability is also not a constraint. Monetary policy is a blunt tool to manage sectoral credit. We believe India should follow the Tinbergen rule, with at least one tool for each target: policy rate for price stability and macroprudential tools for financial stability. The RBI’s measures are already slowing unsecured lending, and as the full impact of tighter norms materializes, the credit-deposit growth gap is likely to narrow, in our view.
Overall, we believe an inflection in monetary policy is around the corner, and it is unlikely to be shallow. Monetary policy works with long lags, and after a year of low underlying inflation, there is both scope and a need for policy recalibration.
For more insight, read our full report.
Contributor
Sonal Varma
Chief Economist, India and Asia ex-Japan
Aurodeep Nandi
Asia Economist
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